August 14, 2013
Interviewed by: David Snow
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How Small Institutions Tap Private Equity

Martin Day, a partner in the Canadian firm Caledon Capital Management, describes what it take for smaller institutional investors to successfully allocate to private equity. He outlines the resources and network needed to source good opportunities and access the types of funds that generate outsized returns.

Martin Day, a partner in the Canadian firm Caledon Capital Management, describes what it take for smaller institutional investors to successfully allocate to private equity. He outlines the resources and network needed to source good opportunities and access the types of funds that generate outsized returns.

How Small Institutions Tap Private Equity

A Privcap Conversation with Martin Day of Caledon Capital

You provide guidance to smaller institutional investors. What particular challenges do they face?

I think the main thing is it’s a function of size. And with smaller, medium-sized pension funds or institutions, we define not roughly kind of $1 to $15 or $20 billion plans. The biggest challenge is lack of scale. And when they don’t have a scale that manifests itself in a few ways: one is they’re really not able to build up the infrastructure, so to speak, the team size etc. that the larger plans have. With the larger team, they’re able to simply access and do the type of diligence; if they had the larger teams, they would be able to do the type of diligence that the larger plans do. So it limits their ability really to look at many opportunities. I think it limits their ability to go sufficiently deep into the opportunities and diligence them in the way that the larger teams would.

I think the smaller plans that are representing smaller amounts of capital simply – at the end of the day – don’t get the access to the same types of opportunities that the larger plans get. So certain opportunities will simply find their way to larger pools of capital, and they’ll just bypass smaller ones along the way. I think it’s also an inability, for example, to execute on co-investments. So it doesn’t enable them to have as diversified a strategy as some of the larger plans might have. They might be able to make some fund commitments – let’s say specifically in private equity – but it’s going to be very difficult to execute on co-investments for a smaller team that might be one or two people. We believe that the challenges are significant, and frankly, the whole reason we’re in business, in a sense, is that when we were sitting at OMERS many years ago or so, we would get a lot of small or medium-sized pension funds kind of asking us, “Hey, is there a way we can access some of the same things that you’re doing, some of the more sophisticated strategies that larger plans are doing?” and that’s what we hope to try to enable people to do.

You mentioned your time at OMERS. What did you learn from working there that informs your work today?

It kind of ties in with scale and size, and what we were able to do at OEMRS over the years that I was there was really evolve the program from what was originally a pretty much strictly fund investing strategy to a fund and co-investment strategy, and then ultimately to what it is today, which is principally a 100% direct GP like strategy. And what we’re able to do, and the only reason we were able to do it, was really because we were able to establish the type of team and the scale that smaller plants can’t do. So today, for example, a team at OMERS – or similarly-sized Canadian plan – there’s probably 45 people or so on the team. And therefore on that kind of team you get the breadth of experience, the depth of experience. You get people with operating backgrounds. You get people with multiple backgrounds.

What I saw in the years at OMERS is that you need that type of scale to really access the type of strategy that an OMERS was able to do. And really that again ties in with the limitations of small and medium-sized plans. And what we tried to do in kind of one quick, or two quick, sentences in a sense is really try to aggregate up these smaller, medium-sized plan in a sense and really give them, in a sense, that benefits of scale by Caledon building that scale. So we build the large team, and then they basically access that scale really on an outsourced basis. And then they can benefit from the same types of strategies.

What sectors, strategies, geographies, etc., draw particular interest from your clients today?

So what Caledon has seen in the last three or four years or so is a very, very significant growth in allocations to real assets as they call them in the US and specifically infrastructure as we tend to call it more in Canada. That, without a question, I think is the newest and strongest trend that we’re seeing amongst our client bases. So these are new allocations, and their significant in some cases. And they are generally not coming from private equity. So the private equity strategy is still intact with these plans.

But these are new allocations generally coming from – whether it’s fixed income in some places or possibly public equities –but there’s a very, very significant and strong move to these. So we’re seeing a lot of demand for help in building a strategy for infrastructure, help with after the strategy built is of course the execution of the strategy and then the management of the portfolio that’s built after that. I think if there’s a trend that we’re seeing a little bit on the private equity side – just for the record – we do believe that private equity, like infrastructure and other alternatives, is very much a long-term game, and we don’t really believe that it’s kind of timing the market type of strategy. So we believe that it’s a steady as she goes – you develop your strategy and your allocation for private equity, and you deploy it over time.

Having said that, we do recognize that there are new, sometimes, and emerging trends that begin to develop within the industry. To the extent we think there are short … I should say longer than a month or two kinds of trends. If it’s a few year trend that we believe is developing then we will absolutely begin to focus on that. And an example of that is just the credit and distress space – particularly in Europe. And a number of years ago – I guess it’s post crisis – but there’s as we all know – major dislocation in the banking and financial systems in Europe. And there’s been some real opportunity, I think, to put money to work on a very advantageous basis in that area. So that’s kind of a smaller trend within the private equity world that we’ve been following up on.

Do you think the type of “mega-deals” of the mid-2000s will ever come back?

I think mega deals – and of course a lot of it is in the definition of what a mega deal … you could almost define it as the largest deals of the moment, so there are always mega deals. But at the type that we were seeing a number of years ago, I do believe that there is a cyclical nature to that, and I do believe that we will see very large deals. I mean Dell is an example of a deal that’s been bubbling around for a while and certainly would qualify, I think, as a mega deal. At the end of the day, mega deals are just a function of available capital. And available capital means equity capital and debt capital. The debt capital is a function of the debt markets, and that for sure is a cyclical driven thing. And right now there is abundant debt capital available on relatively good terms, very much like pre-financial crisis times.

The equity side is really a function of how much capital is being raised by the private equity players. So what we saw, I think, in the last cycle of mega deals was really very, very large funds combining with, or partnering with, other very, very large funds to, therefore, enable them to take down very significant chunks of equity and large deals. I think the difference you’re going to see now, frankly, is that investors don’t like those generally. And I think even the GPs don’t like that as their first call for additional capital – I think especially as some of these deals have been troubled. It’s been difficult for them to necessarily work those out with other GPs at the table. I think what’s going to fill that gap but still enable there to be very significant equity is the co-investment side of the business. And the top strip of co-investors are looking to provide and write very, very big checks. So there’s hundreds and hundreds of millions of dollars available on the co-investment side. And that along with the capital of the GPs will enable there to be some pretty big deals done again.

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